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Fed Forecasts Faster Growth as Economy Improves

WASHINGTON — The Federal Reserve disclosed on Wednesday that policy makers had substantially upgraded their forecasts for how much the economy will grow this year, though they expect unemployment to remain painfully high for some time.

Top Fed officials now expect the output of goods and services to grow by 3.4 to 3.9 percent this year, up from the previous forecast, released in November, of 3 to 3.6 percent. But their grim outlook for the job market was largely unchanged: 8.8 to 9 percent unemployment this year, only one-tenth of a percentage point lower than its November forecast.

If the Fed’s most optimistic forecast were realized, it would be the fastest annual growth since 2004, when the economy expanded by 3.6 percent. But experts say even that rate of growth would only bring unemployment, now at 9 percent, down slowly — to slightly less than 8 percent by the end of 2012, when President Obama will seek re-election.

The forecasts did not change the view that the Fed should continue the $600 billion program to stimulate the recovery by buying government securities, a step begun in November and scheduled to run through June. The Fed said it based its expectations on an improvement in consumer spending in the fourth quarter, though Fed officials were uncertain how long that would last, according to minutes of the Fed’s last policy meeting in late January, released on Wednesday.

“On the one hand, the additional spending could reflect pent-up demand following the downturn, or greater confidence on the part of households about the future, in which case it might be expected to continue,” the minutes noted. “On the other hand, the additional spending could prove short-lived, given that a good portion of it appeared to have occurred in relatively volatile categories such as autos.”

At the January meeting, the Federal Open Market Committee, the Fed’s main policy arm, voted unanimously to continue the $600 billion Treasury purchase plan, the second round of a strategy that is intended to push down long-term interest rates to ease credit and spur growth. The strategy, known as quantitative easing, has been controversial — critics say it could set the stage for future inflation and asset bubbles — but the Fed has been fairly unified behind it.

The minutes indicated that Fed officials saw a diminishing risk of deflation, a protracted fall in prices of the sort that has afflicted Japan for more than two decades. That fear of deflation was a principal factor behind the decision in August to set the stage for the bond purchases.

Other economic reports issued on Wednesday supported the Fed’s view of an economy starting to gather some steam. The Commerce Department reported that new home construction rose by the largest amount in 20 months, and the Labor Department reported that wholesale prices rose sharply in January, driven up by gasoline and pharmaceuticals. Excluding the volatile food and energy categories, the index rose by the most in more than two years.

The Fed’s own report on industrial production in January was more mixed. Factory output rose for the fifth consecutive month, pushed by strong car and truck sales, but utility and mine output fell, leaving the overall level of production lower, the first month-to-month decline in 19 months.

For their part, investors have been bidding up stock prices steadily since late November. The Dow Jones industrial average closed at 12,288.17 Wednesday, up 61.53 points, or 0.50 percent.

“Things are moving in the right direction, and the Fed is taking that into consideration,” said Martha A. Starr, an economics professor at American University here, and a former senior economist at the Fed. “The higher growth rate bodes well, perhaps, for an earlier recovery in the labor market than had been expected, but even with the better growth prognosis, it will take a while for the average person on the street to feel it.”

The minutes painted a picture of a group that was not quite certain about how long the economy would take to recover from the 2007-9 recession — the longest downturn since the Depression.

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“On the downside, participants remained worried about the possible effects of spillovers from the banking and fiscal strains in peripheral Europe, the ongoing fiscal adjustments by U.S. state and local governments, and the continued weakness in the housing market,” the minutes stated.

“On the upside, the recent strength in household spending raised the possibility that domestic final demand could snap back more rapidly than anticipated. If so, a considerably stronger recovery could take hold, more in line with the sorts of recoveries seen following deep economic recessions in the past.”

The minutes noted that most Fed officials viewed the large slack in the economy — the economy’s underperformance relative to its potential — as “likely to remain a force restraining inflation,” and believed that while price declines were unlikely, inflation was likely to remain below its desired level (2 percent or slightly below) “for some time.”

Some officials also said that if the public doubted the Fed’s willingness to reduce its huge balance sheet — by selling the financial assets it acquired as a response to the crisis — when the time comes to do so, “the result could be upward pressure on inflation expectations and so on actual inflation.”

The Fed chairman, Ben S. Bernanke, has repeatedly stated that the Fed was ready to act if inflation posed a threat.

Some private economists think the Fed might have to raise interest rates as early as this year, but others say a rate increase is unlikely to occur until 2012 at the soonest, barring an unexpected jump in inflationary pressures.

“A few members noted that additional data pointing to a sufficiently strong recovery could make it appropriate to consider reducing the pace or overall size of the purchase program,” the minutes stated, referring to the $600 billion program. “However, others pointed out that it was unlikely that the outlook would change by enough to substantiate any adjustments to the program before its completion.”

A version of this article appears in print on February 17, 2011, on Page B1 of the New York edition with the headline: Fed Raises Its Forecast For Growth. Order Reprints|Today's Paper|Subscribe